This article examines the content of Regulation Z disclosures and the procedures for compliance with Regulation Z. This is the second part of a two-part series discussing Regulation Z. To read the first part of this series, click here.
Table of Contents
2. Duty to prepare disclosures
3. Timing the delivery of disclosures
5. No commitment heralds re-disclosure
6. Penalties for Regulation Z violations
7. Three-business-day right of rescission
Regulation Z (Reg Z) requires lenders who make personal-use loans and become subject to Reg Z to disclose all the following information to their borrowers:
- the identity of the lender;
- a statement about the lender’s security interest in the property;
- a reference advising the borrower to review loan documents for default, assumptions, and similar information;
- the dollar amount financed;
- the term of the financing;
- the payment schedule and total dollar amount of all payments;
- the demand (call) features;
- prepayment and late-payment penalty information;
- the assumption policy on the loan;
- a statement about any required deposit other than for impounds;
- a separate good-faith estimate itemizing costs;
- the total of all financing charges; and
- the Annual Percentage Rate (APR). [12 Code of Federal Regulation §226.18; see first tuesday Form 221]
The APR is a restatement of the finance charge expressed as an annualized percentage. Calculation of the APR is complicated. Thus, the Federal Reserve Board expects lenders to use a calculator or a computer program to figure the APR.
Computer programs which perform document preparation and many different types of calculations range in price from hundreds to thousands of dollars depending on the needs of the lender or loan broker. To find a program, search for “Loan Origination Software” on any internet search engine.
A broker who arranges a loan, but does not also make (fund) the loan, does not have the primary responsibility to prepare and deliver Reg Z disclosures to the borrower; the responsibility lies with the private lender whose name appears on the note.
However, brokers arranging financing need to be knowledgeable about Reg Z, even if they are not themselves directly required to make the disclosures when they do not also make (fund) the loan.
For example, a loan broker arranging a loan for a private lender must be familiar with federal disclosure requirements since:
- the lender may be unaware of the details required in his disclosure; and
- both the lender and the borrower will rely on the loan broker to be familiar and comply with legal formalities for structuring the loan transaction. [Barry v. Raskov (1991) 232 CA3d 447]
Further, no one may charge the borrower a fee for preparing Reg Z disclosures. Thus, the loan broker or the lender preparing the disclosures must absorb the cost and time in preparation as part of their cost of doing business, i.e., overhead. [24 CFR §3500.12]
However, complying with Reg Z does not exempt a private lender from also delivering California-mandated disclosure statements due the borrower. [See first tuesday Form 204 (DRE Forms RE883) for loans, and first tuesday Form 300 for carryback financing]
Further, in brokered loans or carryback sales, the broker has the duty to prepare the California disclosures. In nonbrokered carryback sales transactions, the seller does not need to make the California disclosures unless the seller is also a licensed broker or attorney. [Calif. Civil Code §§2956-2957]
Timing the delivery of disclosures
When the purpose of a private lender’s real estate loan is to fund a personal use, the time for delivery of Reg Z disclosures is based on:
- the type of property securing the loan; and
- the borrower’s use of the property.
Three Reg Z categories establish the types of property a personal-use loan might encumber:
1. A single-family residence (SFR) or duplex: This type of property is acquired by the borrower, funded by a purchase-assist loan and is to be occupied by the borrower as his principal residence. Three-or-more unit residential properties, whether or not occupied as the borrower’s principal residence, are not classified as primarily for personal use and are exempt investments uncontrolled by Reg Z.
2. One-to-four unit residential property: The borrower presently owns and occupies, all or in part, this type of property as his principal residence, and it is to be further encumbered by an equity loan (or refinance).
3. Property other than the borrower’s principal residence: This type of property is presently owned by the borrower and will be further encumbered by a personal-use equity loan, comprising real estate held by the borrower for business, investment (rental), or agricultural operations, including vacation and second homes, whether owned and further encumbered by a personal-use loan or acquired with funds from a purchase-assist loan.
With a mental grip on the three categories of property securing personal-use loans, and before the private lender may fund and close a Reg Z loan encumbering property within any one of the three categories, the lender and his broker must determine:
- which Reg Z disclosures, cost estimates, re-disclosures, rescission notices, and Section 32 supplemental disclosures are to be prepared; and
- the timing for delivery of these documents and the signing of loan escrow instructions.
The Reg Z documents to be prepared based on the category for the property which will be encumbered by a personal-use loan and the timing of their delivery are:
1. For SFRs or duplexes to be acquired with funds from a purchase-assist loan and occupied as the borrower’s principal residence:
- a good-faith estimate of costs is delivered to a borrower with or before delivery of the Truth-in-lending (TILA) Reg Z disclosures [See first tuesday Form 204 (DRE Form RE883)];
- the TILA (Reg Z) disclosures are delivered (usually with the cost estimate) by handing or mailing to the borrower within three business days after initially receiving the borrower’s loan application [See first tuesday Form 221]; and
- a re-disclosure of TILA (Reg Z) disclosures (including a revised cost estimate), when changes in loan terms previously disclosed require re-disclosure, is delivered before entering into loan escrow instructions (or an earlier written loan commitment acquired from the lender).
Editor’s note—The rescission notice never applies to a purchase-assist, principal residence loan, and that loan is never subject to Section 32 loan analysis or supplemental disclosures. 2. For one-to-four unit residential property the borrower owns and occupies as his principal residence which is further encumbered by a personal-use equity loan or refinance:
- a good-faith estimate of costs is delivered to a borrower with (or before) delivery of the TILA disclosure [See first tuesday Form 204 (DRE Form RE883)];
- the TILA (Reg Z) disclosures are delivered before entering into loan escrow instructions (or an earlier written loan commitment from the lender) [See first tuesday Form 221];
- a re-disclosure of TILA (Reg Z) disclosures (including a revised cost estimate), when changes in loan terms previously disclosed require re-disclosure, is delivered before entering into loan escrow instructions (or an earlier written loan commitment acquired from the lender);
- notice of right of rescission is delivered to all co-owners who occupy the property as their principal residence and whose ownership interest will be further encumbered by the loan (usually being the borrower);
- any supplemental Section 32 disclosures are delivered to the borrower when the loan is further classified as a Section 32 loan; and
- all these documents, as well as loan escrow instructions, must be delivered to the borrower more than three business days before closing.
Editor’s note—Since the right of rescission exists only in this category of loans, all these disclosures, notices, and escrow instructions must be delivered more than three business days before closing. Only after expiration of this rescission period (plus time to confirm no rescission has occurred) may escrow close and loan funds be released.
3. For property other than the borrower’s principal residence which is further encumbered by a personal-use loan:
- a good-faith estimate of costs is delivered to the borrower on or before delivery of the TILA disclosures [See first tuesday Form 204 (DRE Form RE883)];
- the TILA (Reg Z) disclosures are delivered before entering into loan escrow instructions (or an earlier written loan commitment from the lender) [See first tuesday Form 221]; and
- a re-disclosure of TILA (Reg Z) disclosures (including a revised cost estimate), when changes in loan terms previously disclosed require re-disclosure, is delivered before entering into loan escrow instructions (or an earlier written loan commitment acquired from the lender).
Editor’s note—Since this third category of loans does not further encumber a borrower’s principal residence, a right of rescission notice is never required nor is the loan subject to Section 32 classification or supplemental disclosures.
A basic rule of conduct for loan brokers and lenders handling a Reg Z loan is to deliver all Reg Z (TILA) documents before allowing the borrower to sign escrow instructions. For a Right-of-Rescission loan, after all Reg Z documents have been delivered and the borrower has signed and returned loan escrow instructions, the borrower has three business days before the loan escrow can close, during which time he may cancel the entire loan transaction without incurring costs.
Only after the last disclosure and the last rescission notice have been delivered, and the borrower’s signed escrow instructions returned to escrow and more than three business days have passed, may the lender fund and close escrow.
Who receives disclosures Reg Z disclosures are made to individuals who are borrowers. When the borrower is an entity, such as a partnership, limited liability company, or corporation, Reg Z does not apply. [12 CFR §226.3(a)(2)]
A lender who makes a personal-use equity loan or refinance secured by a further encumbrance of the borrower’s current principal residence must deliver Reg Z disclosures to everyone whose ownership interest in the residence will be security for the loan.
Further, two copies of the rescission notice are to be delivered to each named borrower on these principal residence equity loans. [12 CFR §226.23(b), 12 CFR §226.17(d); Regulation Z Staff Commentary §226.17(d)-2]
A guarantor of the borrower’s obligation to repay a Reg Z loan or carryback note does not need to be given Reg Z disclosures. Guarantors do not sign the note (or trust deed) since their property is not encumbered and they are not the borrowers. [Staff Commentary §226.2(a)(11)]
Again, the real estate encumbered by a trust deed to secure a personal-use loan originated by a private lender and controlled by Reg Z includes all types of real estate and is not limited to the borrower’s principal residence. [Staff Commentary §226.2(a)(19)-1]
Consider a borrower who obtains a loan to purchase a recreational boat. The loan is secured by a trust deed on a rental property he owns. The loan is the sixth personal-use loan secured by real estate that the lender has made within the calendar year. Must the lender make Reg Z disclosures?
Yes! Since the proceeds from each of the six loans were for the borrower’s personal use, Reg Z applies to this, the sixth loan. More importantly, since the lender has made more than five personal-use loans secured by real estate during the calendar year, the lender is now required to make the appropriate Reg Z disclosures on all further Reg Z loans for the duration of this year and next year as well.
No commitment heralds re-disclosure
After delivery of Reg Z disclosures, a lender who changes any aspect of the loan to alter the annual percentage rate (APR) yield by more than 1/8 of 1% before closing must deliver an amended disclosure. [12 CFR §226.19(a)(2)]
Accordingly, the lender, not being bound by a written commitment to make the loan as originally disclosed, can change the offered terms at any time prior to executing closing instructions and delivering loan documents to escrow. Items which do not affect the rate of return, such as due-on-sale or prepayment penalty provisions, may be added to the note or trust deed without having to amend the disclosure.
Thus, the re-disclosure rules do not protect personal-use borrowers from unscrupulous lenders. A borrower may proceed with financing based on a favorable upfront Reg Z disclosure, only to be surprised by an unfavorable Reg Z re-disclosure as late as the date for close of escrow. The change in the APR is typically due to the lender’s sudden increase in the rate of interest at time of closing, an event foreseeable by the borrower.
When a borrower receives a re-disclosure, due to a change in the APR originally disclosed, and loan escrow instructions for signatures, he will have already invested extensive energy and money in the transaction or situation being financed by the loan. Thus, he will be reluctant to cancel the financing he lacks as immediately available alternative source of financing to fund his needs.
The remedy for this untimely surprise rate of interest (new APR) is implemented by the borrower on opening a sales escrow by submitting a separate application to a backup lender. To protect their turf and avoid failed applications, each lender will, in writing, typically recommend that the borrower not do so, an inadvertent catch-22 for the improperly counseled borrower who is not wise to lender tactics.
Penalties for Regulation Z violations
If a lender fails to timely deliver correctly prepared Reg Z disclosures to a borrower, the borrower may recover from the lender the total of:
- out-of-pocket losses caused by the incorrect or absent disclosure;
- twice the amount of the finance charge, limited to $1,000; and
- court costs and attorney fees. [15 United States Code §1640(a)]
Out of pocket losses result when fees are undisclosed or underestimated in the good-faith estimate of costs and later charged to the borrower. These amounts can be recovered.
The finance charge includes the dollar amount of the interest payable over the life of the loan. [12 CFR §226.4]
The difference between this total finance charge over the life of the loan and the lesser estimate in Reg Z disclosures is the recoverable loss, subject to limitations. However massive this amount of interest may be, the interest recovery is limited to $1,000.
A borrower must bring any action to recover damages from a lender within one year of the lender’s Reg Z violations. [15 U.S.C. §1640(e)]
Further complicating a money recovery, a lender is not liable for unintentional math errors in the disclosures. [15 U.S.C. §1640(c)]
A lender may also avoid penalties by correcting an error in the Reg Z disclosures within 60 days after discovering the error and notifying the borrower. However, the correction will not shield the lender from liability if the borrower first notifies the lender of the error or has previously commenced legal action against the lender. [15 U.S.C. §1640(b)]
A lender who knowingly makes inaccurate disclosures or willfully miscalculates the APR may be fined up to $5,000 and sentenced to a year in jail. [15 U.S.C. §1611]
All said, this exposure to a penalty is not likely to keep lenders in line and acting within the parameters of Reg Z.
Three-business-day right of rescission
A borrower on a Reg Z loan is only entited to a notice of right to rescind (cancel) the loan transaction, at no cost or expense to him, if:
- the property to be security for the loan is a one-to-four unit residential property which is presently owned and occupied, all or in part, by the borrower (and others whose ownership interest will be encumbered) as his principal residence; and
- the property will be further encumbered to secure an equity loan or refinance, or as additional or substitute security for an existing Reg Z loan, which funds or funded a personal use of the borrower, his family, or household. [12 CFR §226.23(a)(1); see first tuesday Form 222]
Loans on which the borrower is not entitled to a Notice of Right to Rescind include:
- purchase-assist loans to acquire a principal residence;
- commercial loans funding a trade, business, investment, or agricultural operation of the borrower, even if the loan further encumbers the borrower’s one-to-four unit principal residence, as these loans are exempt from Reg Z; and
- a refinance of an existing personal-use loan encumbering the principal residence, unless the amount borrowed exceeds the total sum of the principal rolled over, accrued and unpaid interest, and the costs of the refinance transaction. [12 CFR §226.23(f); Staff Commentary §226.23(1)]
The right to cancel during the three business days following receipt of the last Reg Z document and loan escrow instructions in a rescindable transaction can be waived to meet a bona fide personal financial emergency. Each borrower whose principal residence is to be encumbered must join in the waiver, usually consisting of a husband and wife. No preprinted waiver form can be used. Thus, the waiver must be handwritten to describe the emergency, be worded as a waiver of the right to rescind, and be signed by all owner-occupants whose interest in the property will be encumbered. [12 CFR §226.23(e)(1)]
The private lender, the broker, and the escrow involved must not allow the release of any funds to the borrower until after the three-business days have lapsed, unless waived. Delivery of funds to the borrower before the lapse of the three-business-day period is prohibited.
The three business days begin on the first day after the borrower’s receipt of the notice of right of rescission, all other Reg Z disclosures having been properly delivered and escrow instructions signed and returned.
Waiver aside, the rescission (cancellation) period expires and the loan may fund if none of the borrowers mailed or otherwise handed a notice of rescission to the lender. Also note, the three-business-day period runs from the last occurrence of signing loan escrow instructions, delivery of disclosures, or delivery of the rescission notice. [12 CFR §226.23(c); Staff Commentary §226.23(a)(1)]
Expiration of the three business days can be tricky, not because of the math, but because the lender must confirm (be reasonably satisfied) a mailing of a cancellation by the borrower prior to the midnight hour of the third day is not still in transit.
Thus, it is imperative for the lender and broker involved to get a written confirmation after the third day and before funding, signed by all the borrowers who hold the right to rescind, that the borrowers did not exercise their right to cancel by sending a notice of rescission. To do otherwise is to act at the peril of the borrower’s rescission, followed by the lender’s cancellation of the trust deed within 20 days after closing the loan escrow and attempts by the lender to recover funds disbursed by escrow, all due to a delayed receipt of a timely mailed cancellation (without also canceling escrow).
Delivery of both Reg Z documents, i.e., the TILA disclosures (one copy to each) and the rescission notice (two copies to each), is best done by having the borrowers and encumbered property owners sign each document, acknowledging and dating their receipt. When they have done so, the three-business-day period which must follow both the disclosure and the rescission notices, as well as the signing of the loan escrow instructions, called consummation of the loan, begins the next business day as day one of three.
A notice of rescission given by any co-owner of the property who is entitled to rescind cancels the loan escrow transaction. All this comes at no cost to the borrower when avoiding a rescindable loan transaction. [12 CFR §226.23(a)(4)]
Should a lender already hold an existing Reg Z personal-use loan which is either unsecured or secured by property other than the borrower’s residence, and the borrower now agrees to provide the equity in his personal residence (one-to-four units) as additional or substitute security, the right of rescission does not affect the pre-existing loan. In the event the borrower cancels, he is merely terminating his agreement to further encumber his principal residence, not the note evidencing the pre-existing personal-use loan. [12 CFR §226.23(a)(1)]
Thanks for the update and newsletter. Very helpful, please keep up the good work and keep the letters coming